Sun Life Financial Asia has dialled down its positions in Hong and China equities over the past year in a bid to absorb risks stemming from geopolitical tensions.
Even though valuations are now relatively cheap in both markets, with most macroeconomic risks being priced in, Sun Life is not likely to be bullish towards them any time soon.
Instead, the Asian arm of the Canadian life insurer will aim towards greater diversification across Asia, especially in the Association of Southeast Asian Nations (Asean) markets.
This is in line with its long-term strategic asset allocation target since 2020, while it is also focusing more on a tactical asset allocation amid downside risks.
“When you focus purely on the fundamental market drivers, which is basically corporate earnings, interest rates, Covid impact on the consumer, and regulatory risk particularly, most of that is priced into the earnings,” said Jimmy Weng, Hong Kong-based head of equities, Asia at Sun Life Financial Asia.
Valuations of stocks in the two markets are now trading at about nine times multiples.
“That’s basically going back to your valuation levels of the global financial crisis in 2008, or back to 2011. These are trough distressed valuations because it's pricing in a number of major risks,” he noted.
But he thinks what has not been priced in by the market is what he called “high-impact, low-probability” risks.
This includes tail risk events such as Chinese military activity surrounding Taiwan, escalating trade and tech war tensions, cutting US dollar funding to systematically important Chinese banks for links with Russia, and risks of a Hong Kong dollar de-peg.
“That's what pretty much keeps me awake at night. Not so much about China’s GDP number, not about whether China is going to open up its Covid policy and mobility, or maybe Alibaba and Tencent earnings results,” Weng told AsianInvestor in an interview last week.
For example, any direct Chinese military activity would disrupt the overall fundamental flows and create more risk-off scenarios. “I think that tension with China and US has never really gone away,” Weng said.
In response to US House Speaker Nancy Pelosi’s visit to Taiwan on Aug 2, China has launched unprecedented live-fire military drills surrounding Taiwan. Both Taiwan and US military are on high alert.
“These are risks that are very hard to be able to put an accurate valuation of multiples on… I think that's really what's going to keep investors from getting bullish particularly on the Hong Kong and China markets,” he stressed.
Overall, Sun Life will keep focusing on the fundamentals with Weng believing that valuation are looking attractive, particularly from an earnings and yield perspective.
“However, valuation is really just one side of the story,” Weng said.
DIVERSIFYING ACROSS ASIA
Sun Life operates in eight markets across Asia, with Hong Kong and the Philippines its biggest markets. Its assets under management in Asia stand at C$105 billion ($81.2 billion) as of the end of June.
Credit investment is its primary asset class, followed by equities. Most of its equity investment is in Asia.
Over the past year, Sun Life has lowered its equity allocation. Weng thinks any further downside would make them more bullish on the equity market.
“I think our base case scenario points to a higher upside for equities rather than for credit, particularly because equities are pricing in a bear case scenario, whereas I think credit right now is a more fair base-case evaluation,” he said.
Up until July 2021, Hong Kong and mainland China made up the largest portion of Sun Life’s equity portfolio. But the allocation now has been well diversified across Asia, with Asean markets becoming relatively more attractive.
“Indonesia and Philippines for example, are less correlated with China markets and are well supported by recovering domestic demand and positive bottom-up earnings growth. Top-down positioning should gradually improve with foreign ownership now lightly positioned,” he said.
But there are also macroeconomic risks including tighter monetary policy, higher rates, higher inflation expectation, and slowing global growth, particularly pressuring some smaller and illiquid Asean markets, in the coming months.
Hence, Sun Life’s equity portfolio is in a bear-case scenario and positioned for the increased likelihood of stagflation, making them tend to diversify more broadly across the region.
This also keeps them less focused on export-oriented economies such as Taiwan and Korea.
“If we're starting to see peak inflation within the region, central banks can probably refrain from tightening monetary policy further and we’ll see if there are expectations on lowering rates … then I think the themes and the fundamentals will go back to corporate earnings and reopening plays,” Weng said.
And then with the easing of Covid policy set to increase mobility, there's will be “pockets of opportunities” to diversify more in other parts of Asia, he said.
For the rest of 2022, Sun Life will still be quite selective and tactical in its positions, particularly with the “big overhang” of high-impact, low-probability events.
FOCUS ON ALM
Currently, Sun Life’s Hong Kong and China equity strategies are predominately passive, including broad-base index exchange-traded fund (ETF), fund investment, and other thematic ETFs.
For smaller and illiquid markets like the Philippines, Indonesia, and Vietnam, where there is local and idiosyncratic risk and a lack of passive exposure, Sun Life is taking a more active approach.
At the same time, Weng’s equity team has been working more closely with the Asia asset liability management (ALM) team to put various hedges on the portfolio with more risks in the Asian equity market, extending from foreign exchange risks to downside risk protection on a bigger scale for every market it invests in.
Major hedging tools, meanwhile, are plain-vanilla options, which Weng regards as a “cheap and efficient way” to hedge downside risk. They are also looking at other hedging strategies, such as futures and collars.
In Hong Kong, for example, they work with many local brokers on broad-based index hedges this year to protect the solvency ratio and minimise volatility for company earnings.
In terms of sector selection, Sun Life will continue to focus on clean energy electric, vehicle policies, and relevant ESG themes.
“That's something that is not just about doing something good, but actually promoting the earnings growth. That's really where we see the growth potential within Asia,” Weng said.
On return prospects in the second half and further towards next year, Weng noted that the market has priced in low valuations, which probably won’t see a major turnaround until sometime next years when earnings start to reset, market consensus calms down, and there is more clarity on Covid mobility.
“I think that will start to drive fund flows back into Asia,” he said. “And then we'll start to see the low base start to trigger a re-rating on multiples.”